mortgage 35 years vs 25 years vs 15 years

[alexh]

Hello fellows, a question from a beginner investor.

Im still unsure about how a 35 year mortgage on a property i purchased can turn to worse in changing times. (In Edmonton, Westmount)

i have positive cash flow, 10% rule applied.
And put only a minimum 5% down.

What are some of the factors or market changes that could hurt me in my investment in the long future. What should i look out for.

What if interest rates reach 20% in 20 years from now. is that a possibility?
How do you mediate an investment & fast rising interest rates? (sell it?)
What kind of things does someone have to look out for ? (long term) (recession, vacancy rate, rental prices dropping)

Im just trying to make sense of what kind of changes can negatively affect this investment over a 35 year period.
And trying to get a picture of the worse case scenario to see if i could handle it for 1 single property vs a multitude of ownerships.

Thanks, hope the question makes sense.

 

[alexh]

This is a quote borrowed in another post to answer myself, written by ThomasBeyer.
The property in question is a 420,000 home with a separate basement suite.


`` That`s how the US got into trouble: too many expensive homes too overlevered !

Do not over-lever ! Use mortgages prudently ! A house over $350,000 is, in most cases, not an investment property .. it is speculation on (possibly, likely) equity upside that will take years to materialize ! You must have cash-flow to hold onto an asset .. cash-flow that is realistically AND CONSISTENTLY achievable only with cheaper properties .. We have yet to by an asset over $78,000/door .. and occasionally I think that is high ..

Long-term wealth is built by HOLDING long-term .. and that requires enough cash coming in to pay all expenses going out: taxes, management fees, vacancies, utilities, insurance and mortgage interest.

If the property does not cash-flow with a 6%, 25 year amortized mortgaged using realistic rent and expense assumptions: do not buy it .. or if you own it: sell it .. and find s.th. that can be held more comfortably long-term (even if the mortgage you have is 4% and 35 year amortization) !!! ``

 

[Thomas Beyer]

In this post here I show the impact on leverage using some growth assumption, plus I have a chart on inflation.



http://myreinspace.com/rein_members_only1/Members-Only_Discussion/81-6621-50_Year_Calgary_House_Price_View.html



The more you are levered, i.e. the less down, the higher the cash-on-cash return in a rising market, but the worse the cash-flow and the higher the risk.



If you lock in a 5 year mortgage, the bank cannot change the rate for 5 years.



Chances are that interest rates will be a BIT higher in 5 years, maybe 1-2% but not double digit as this would imply a very fast growing economy .. which is unlikely. Possible: of course .. but not likely.



In the US 30 year fixed rate interest rates are very common .. and they are around 4.8 to 5.7% for a residential mortgage. In Canada that is not common. a 1 year fixed rate would be 2% more expensive than a 5 year rate .. and availability is slim.



The cheapest money is always the variable rate mortgage, as any bank has to guess where rates will be in 2, 4 or 6 years, and they pass on this risk to you, the consumer, via a higher rate compared to the variable rate.



Also look at this, the 50 year bond rates:

http://myreinspace.com/rein_members_only/Members-Only_Discussion/81-9705-50_Year_View_on_Interest_Rates_in_Canada.html

 

[Nir]

no one knows what the value of your property will be in 5 years when you have to renew your mortgage. The risk you took is that in 5 years you will not be able to qualify/renew either due to your financial strength or/and due to your property`s appraised value. No worries, historically it has been VERY rare/unlikely. on the other hand today`s situation is also uncommon to say the least - that`s why no one knows. we have to accept the fact real estate is not as safe as putting money in the (Canadian) bank. Hence, the expected profit is higher. The following economic rule always work - in a normal market the higher the return the higher the risk. so don`t be surprised there is a long list of things that can go wrong when investing in RE that do not exist when putting the money in the bank. fighting that is like fighting nature. acceptance is better. Due diligence – Yes, cheating ourselves – No.

 

[RedlineBrett]

Nothing is stopping you from turning your 35 yr am into a 25... just pay a little more off each month or invest it elsewhere until your term expires and then pay down some principle!

A longer amortization simply gives you the option of keeping your payments low and using the saved capital for other means.

I have some clients that stick with 25% down, 25yr amortizations. That system works for them. I have others doing 5% down and 35yr amortizations. That is what they have chosen to be the best for their business. One client buys a lot more than the other but the flipside is one has much less portfolio risk than the other.

So.... in the end it is totally up to you, the investor! That`s the beauty of free enterprise.. you get to make these choices for your business!


QUOTE (alexh @ Mar 3 2009, 02:04 PM) Hello fellows, a question from a beginner investor.

Im still unsure about how a 35 year mortgage on a property i purchased can turn to worse in changing times. (In Edmonton, Westmount)

i have positive cash flow, 10% rule applied.
And put only a minimum 5% down.

What are some of the factors or market changes that could hurt me in my investment in the long future. What should i look out for.

What if interest rates reach 20% in 20 years from now. is that a possibility?
How do you mediate an investment & fast rising interest rates? (sell it?)
What kind of things does someone have to look out for ? (long term) (recession, vacancy rate, rental prices dropping)

Im just trying to make sense of what kind of changes can negatively affect this investment over a 35 year period.
And trying to get a picture of the worse case scenario to see if i could handle it for 1 single property vs a multitude of ownerships.

Thanks, hope the question makes sense.

 

[alexh]

QUOTE (investmart @ Mar 3 2009, 08:28 PM) no one knows what the value of your property will be in 5 years when you have to renew your mortgage. The risk you took is that in 5 years you will not be able to qualify/renew either due to your financial strength or/and due to your property`s appraised value. No worries, historically it has been VERY rare/unlikely. on the other hand today`s situation is also uncommon to say the least - that`s why no one knows. we have to accept the fact real estate is not as safe as putting money in the (Canadian) bank. Hence, the expected profit is higher. The following economic rule always work - in a normal market the higher the return the higher the risk. so don`t be surprised there is a long list of things that can go wrong when investing in RE that do not exist when putting the money in the bank. fighting that is like fighting nature. acceptance is better. Due diligence – Yes, cheating ourselves – No.




Hello invesmart, and thanks but im not sure i understand what this quote specifically means :
``The risk you took is that in 5 years you will not be able to qualify/renew either due to your financial strength or/and due to your property`s appraised value``.

 

[Nir]

The following example shows why both financial strength and appraised value can affect Financing:

2009: Alex purchased a property for $200K, took 190K mortgage 5 years term (5% down)

....fast forward to 2014: Alex is required to renew his mortgage:

- Bank`s apparaised value = $200K
- Alex has no employment income therefore banks agree to a maximum LTV of 75%.
----> bank agreed to a 150K mortgage max and expect Alex to pay the difference between principal (~180K) and 150K = $30,000.

In other words, in 2014 Alex will have to pay $30,000 in order not to lose his property.

________________________________

Note: it`s just a worse case scenario example. In my opinion, knowing the type of property you purchase/location/price, you should be among the last investors to worry about it. I`m guessing your challenges are more Time Management and Maintenance related.

 

[TommyK]

QUOTE (alexh @ Mar 3 2009, 02:21 PM) cash-flow that is realistically AND CONSISTENTLY achievable only with cheaper properties .. We have yet to by an asset over $78,000/door .. and occasionally I think that is high ..

Long-term wealth is built by HOLDING long-term .. and that requires enough cash coming in to pay all expenses going out: taxes, management fees, vacancies, utilities, insurance and mortgage interest.

If the property does not cash-flow with a 6%, 25 year amortized mortgaged using realistic rent and expense assumptions: do not buy it .. or if you own it: sell it .. and find s.th. that can be held more comfortably long-term (even if the mortgage you have is 4% and 35 year amortization) !!! ``

WOW. I assume that you only buy multi-level buildings?

 

[realfortin]

QUOTE (investmart @ Mar 3 2009, 08:20 PM) - Bank`s apparaised value = $200K
- Alex has no employment income therefore banks agree to a maximum LTV of 75%.
----> bank agreed to a 150K mortgage max and expect Alex to pay the difference between principal (~180K) and 150K = $30,000.

In other words, in 2014 Alex will have to pay $30,000 in order not to lose his property.
Correct me if I am wrong, as I often am...but...
In this case, he would have had CMHC type insurance on the original mortgage. CMHC insurance is in place for the full
amortization period of the loan including all term renewals.
So in your example, the bank would renew since it is still an insured loan.

It is definately why suffering through high CMHC fees is a good padding. On a 4 unit property it would be 7%, which takes the 1st year and half to pay off, but it is good on a buy and hold strategy of 5 years+

 

[RedlineBrett]

QUOTE (investmart @ Mar 3 2009, 08:20 PM) In other words, in 2014 Alex will have to pay $30,000 in order not to lose his property.

Not true! Banks cannot repossess property or force a sale unless the terms of the loan agreement have been broken and a vast set of hoops jumped through. Basically the only way you can lose your house is if you don`t make your payments. No way would a judge issue a court ordered sale just because a lender changes their business policies at renewal time.

 

[Thomas Beyer]

QUOTE (TommyK @ Mar 3 2009, 11:16 PM) WOW. I assume that you only buy multi-level buildings?
yes, mainly .. I do own a few condos and houses ..

 

[RobMacdonald]

QUOTE (investmart @ Mar 3 2009, 08:20 PM) The following example shows why both financial strength and appraised value can affect Financing:

2009: Alex purchased a property for $200K, took 190K mortgage 5 years term (5% down)

....fast forward to 2014: Alex is required to renew his mortgage:

- Bank`s apparaised value = $200K
- Alex has no employment income therefore banks agree to a maximum LTV of 75%.
----> bank agreed to a 150K mortgage max and expect Alex to pay the difference between principal (~180K) and 150K = $30,000.

In other words, in 2014 Alex will have to pay $30,000 in order not to lose his property.

________________________________

Note: it`s just a worse case scenario example. In my opinion, knowing the type of property you purchase/location/price, you should be among the last investors to worry about it. I`m guessing your challenges are more Time Management and Maintenance related.

So far, banks are still not requiring a client to requalify at mortgage renewal. As Brett mentioned, provided you have met the terms of the mortgage agreement, the bank should not have any reason not to renew your mortgage. If the bank becomes in financial difficulty, then that might be a different story.

I started my banking career in the early 90`s, and experience the very same sort of the thing. Clients started with good equity positions, and then at maturity were in hi-ratio positions or even negative equity positions, and the mortgages were renewed without question.

 

[Nir]

Thank You Rob and Brett for the feedback!

So are you saying that after 5 years, based on the example assuming Alex paid all payments on time, the bank will just "forget" about the 30,000 gap and renew a 180K mortgage? well, that`s VERY good news that there is no such risk of losing the property or getting terrible financing conditions. I just hope you are correct!

(well, obviously no one knows for sure as 2014 is completely unpredictable)

Regards,
Neil

 

[Thomas Beyer]

QUOTE (investmart @ Mar 5 2009, 04:16 PM) ...

So are you saying that after 5 years, based on the example assuming Alex paid all payments on time, the bank will just "forget" about the 30,000 gap and renew a 180K mortgage? ...

two possibilities:
a) not CMHC insured, i.e. conventional up to 80%: usually the computer triggers an automatic renewal letter with interest rates far above market .. and you can renew .. or re-qualify for a lower rate with the same or a new bank .. but yes, the bank has the right to call the loan in 5 years .. and will likely do that if they know that the mortgage is upside down (often they don`t know that)
b) CMHC insured: bank will much more likely renew it, as the risk to the bank is 0 as CMHC will bail them out if you default (hence the low rate and high loan-to-value), or you can go to another bank with the CMHC certificate for the mortgage amount .. but of course if you are upside down it will be tough to get a new CMHC loan .. but the CMHC ticket is good for 25 years !!

 

[Nir]

Thank You for the clarification Thomas,

However, I thought based on feedback from many here, that the more you put down the less risk you are taking (for obvious reasons). However, in a way you explained the opposite - the less you put down the less likely you are to have issues renewing because putting less means you are CMHC insured. It`s like you only win by putting less and I thought there are pros and cons to both options.

Neil

 

[Thomas Beyer]

QUOTE (investmart @ Mar 7 2009, 12:32 AM) Thank You for the clarification Thomas,

However, I thought based on feedback from many here, that the more you put down the less risk you are taking (for obvious reasons). However, in a way you explained the opposite - the less you put down the less likely you are to have issues renewing because putting less means you are CMHC insured. It`s like you only win by putting less and I thought there are pros and cons to both options.

Neil
Of course, the more down, the less the risk .. and the better the cash-flow .. but the lower the cash-on-cash return in an up market ..

you can do both ..

CMHC is INdependent of the down payment .. just the fee that CMHC charges differs .. and for a rental property they cap it at 85% LTV and for one personal residence at 95% LTV

 

[Kimberly]

I`m closing on May 1 on my first student rental with a 95% LTV as my son will be living there. Does anyone know if GenWorth insured mortgages also get the benefit like the CMHC, ie you carry the insured certificate throughout the amortization period? Either with the current banking institution or with whoever I may renew with in 5 years? This is my first high LTV loan below 20% so I`m on new turf here.

Is there any difference between CMHC and Genworth backed mortgages? I went with who the mortgage broker made the best overall deal with at the time.